Three different approaches to investing in technology

Despite growing its revenues 122%*, Nvidia’s Q2 earnings were greeted by investors with a ‘so what?’. The subsequent drop in the share price is a hint at growing investor weariness with the big tech theme that has dominated financial markets for so long. Investors recognise that the sector is ‘priced for perfection’, with limited upside even if revenue growth remains exciting.

That said, there is no doubting the growing importance of technology in our lives. Technology is moving into new industries all the time – from car makers to financial services – and grabbing a greater share of the economic pie. With this in mind, is it possible to find ways to explore the growth in technology, without focusing on the most expensive parts of the market? We see three areas of potential:

Digital infrastructure

In 2006, British mathematician Clive Humby said: “Data is the new oil.” His statement was prescient. Data – collecting it, analysing it, building insights from it – has become the lifeblood of technological advancement. But gathering and interrogating data requires huge energy resources, plus storage and distribution facilities.

The Schroder Digital Infrastructure fund aims to exploit the explosive growth in this digital infrastructure. The group calls it the “fourth utility” and believes it will be crucial in transforming the modern world from an analogue to a digital economy. The fund has three main areas it will invest in: macro towers, fibre optic cables and data centres, holding around 40 stocks from a universe of around 300 companies.

These companies have had a difficult period more recently. They were caught up in the general exuberance around artificial intelligence (AI) and the energy transition during the pandemic, and were then hit hard by rising interest rates. The share prices for many tower companies have been largely static since late 2022. However, they have responded well to a shift in interest rates and their share prices have started to revive since April.

In the meantime, the long-term trend is still sound. The Schroders team says that cloud outsourcing is still in its early stages, while demand for AI and the insights it provides continues to grow. Data centre demand is building: “Forecasters estimate that total demand for data centres, as defined by power consumption, could hit 35 gigawatts (GW) by 2030 in the US market alone, up from 17 GW in 2022.”

Asia

An allocation to Asia can bring in a new flavour of technology investment. In many cases, the supply chain for AI and powerful technological developments – including crucial chips, hardware and parts – is to be found in Asia. Asia is home to, arguably, the most important technology company in the world – TSMC – which provides semiconductors that power some of the most advanced electronics on earth. Almost no technical development is possible without it.

The Matthews Pacific Tiger fund is a generalist fund, but has over a third invested in information technology, including TSMC, Tencent, Samsung and Hon Hai Precision Industry (better known as Foxconn internationally). In addition to semiconductors, these companies are providing cloud services, making parts for smartphones, or making actual smartphones. In its most recent commentary, Matthews said: “The expansion of the AI supply chain, led by large US tech firms, was another supportive theme, particularly for semiconductor hubs in Asia.”

In many cases, these Asian AI-focused companies are nowhere near as expensive as their international peers. TSMC is the most high profile and trades at around 28x earnings** – towards the higher end of its long-term average, but nowhere near the peak. Nvidia currently trades at 48x, lower than the 247x it traded at briefly in 2023**, but still high. Yet TSMC makes all the chips that Nvidia designs. Further down the supply chain, it is possible to find even more attractively-valued companies with a strong pipeline of growth.

Read more about capturing the artificial intelligence theme in Asia

Small-cap innovation

Amazon founder Jeff Bezos famously started the company from a garage in Bellevue, Washington in 1994. The company floated in May 1997 at $18 a share. Those lucky enough to invest just $500 at that point would have bought 27 shares. Those shares would now be worth (after 4 stock splits) around $1.1m***.

This is the type of life-changing investment that draws people to the stock market, and also shows the power of finding good companies early. This is the ambition of the WS Montanaro Global Select fund, which has made ‘life after the magnificent seven’ part of its marketing message. It invests in smaller companies around the world, aiming to find pockets of unique growth – “world-class, well-established companies with business models we understand”. They want market leaders that operate in structural growth markets.

It doesn’t confine itself to technology, but inevitably many of its ideas are to be found in the technology sector. Around 26% is in the information technology sector^ and even more of its stocks are related to technology in some way. Tyler Technologies, its largest holding, is a provider of software to the United States public sector^.

Manager George Cooke says: “On both the previous occasions when we have had this mega-cap dominance and when it felt that they could do no wrong, the following five years turned out to be very good for small-cap investors. History doesn’t necessarily repeat, but we think it’s a good time for investors to reconsider their allocation to small-caps.”

At best, the big technology theme is looking a little long in the tooth, at worst it is testing the limits of valuation. There are other exciting areas of technology that merit a closer look.

*Source: Nvidia, 28 August 2024

**Source: PE Ratio, at 10 September 2024

***Source: Yahoo!Finance, at 10 September 2024

^Source: fund factsheet, 31 July 2024